Monday, November 2, 2009

If this chart does make the case for a V-shaped recovery, then I don't know what does. I have been tracking the relationship between the Institute for Supply Management's Manufacturing Index for more than 10 years, and I have seen it consistently do a great job of forecasting quarterly GDP growth rates. With the October release today, the index is pointing to fourth quarter growth of 4-5%.

Yet I continue to be besieged by negative news and worried investors. Corporations are so worried about the future they are sitting on a trillion dollars of cash, equivalent to about 10% of their assets, according to this morning's Wall St. Journal. Investors are pouring money into bond funds, swelling Bill Gross' Total Return Bond Fund to some $190 billion and making it by far the largest mutual fund. Foreign central banks continue to gobble up Treasury debt by the hundredweight. (And if it weren't the case that the world was desperate for the relative safety of bonds, Treasury would be having a much tougher time financing Washington's trillion-dollar deficits.)

Once again I'll say that the Fed's purchases of Treasury bonds and mortgage-backed securities are not the dominant feature on the bond market landscape. Historically low yields and huge money market funds paying almost nothing are a sign that the world's investors are highly skeptical of just about everything these days. (And of course gold trading at $1060/oz. is just more evidence of the market's fears.) It cannot be the case that the stock market is another bubble in the making when bond yields are so low; it makes a lot more sense to assume that the stock market is about as cheap as the Treasury bond market is rich.

2 comments:

I'm not familiar with the particulars, but if China shifts from buying long-term to buying short-term US debt, then China would be doing just what everyone else is doing: seeking protection from rising interest rates. When China buys US debt it is exposed to the risk of a dollar decline and to the risk of rising bond yields. It can hedge the first risk in the FX market, and it can hedge the second risk by shortening the maturity of its bond purchases. It achieves this latter protection at the cost of giving up yield, especially in today's steep yield curve environment. That the curve is unusually steep and short rates are unusually low is a reflection of a market that is acutely aware that the Fed will have to raise rates by a lot over time time.